Drilling Sector May Have Missed Chance For Consolidation

Despite the announcement of a large offshore drilling merger this summer, the fragmented industry may have missed its chance for further consolidation due to a recent swift cyclical upswing, according to analysts. Shlumberger Ltd.'s announcement in July that it would merge its offshore drilling unit, Sedco Forex, with Transocean Offshore Inc., to form the world's largest offshore driller, was expected to set off a wave of consolidation in the industry, matching some of the activity among oil majors. But analysts now say a rebound in crude oil prices has closed the window of opportunity by prompting companies to hold out for wider operating margins. "We're too far along in the upward cycle to expect any significant new consolidation (in the offshore drilling industry)," said Clay Brethour of Dain Rauscher Weiss. "Companies that were vulnerable to consolidation are looking at the thickening margins and digging in their heels." A deep depression in crude oil prices, which hit rock-bottom last winter, started a round of consolidation among oil majors leading to the planned mergers of BP Amoco/Arco and Exxon Mobil, as well as numerous refining and retail alliances, but due to peculiarities of the offshore drilling business the action there remained relatively muted. "Part of the reason is that offshore drilling companies don't realize substantial savings from mergers, like in other aspects of the energy industry," said Fred Mutalibov of Southwest Securities. "The cost of a single drilling contract remains the same no matter how many rigs you operate, so there have to be other circumstances involved." But the planned formation of Transocean Sedco Forex will work, experts say, because the drilling industry was depressed enough at the time to allow for a relatively cheap acquisition of assets through Wall Street. It also allowed Schlumberger to focus on its less volatile core services to oil and gas companies. Since then, crude oil prices have reached new highs, more than doubling from lows of around $11 per barrel in December 1998 to the current $24.00 per barrel, leading offshore drilling companies to expect wider margins within the coming months. As a result, analysts say any future mergers would be based primarily on the aspiration to achieve 'critical mass' - the ability to afford debt, raise money on Wall Street, and control a larger part of the market - as opposed to operational costs saving. Most offshore drilling companies have already achieved 'critical mass,' though there are a few exceptions, according to analysts, including Marine Drilling and Atwood Oceanic - the smaller players in the patch. "I expect that one or both of these companies will consolidate within the next six to 12 months," said Mutalibov. "But the ripest time for consolidation would have been earlier in the cycle." Atwood and Marine Drilling's stocks have jumped between 50 and 62 percent since their lows this winter on speculation of a merger, compared to a 41 percent jump since winter in the oil services field as a whole. Mutalibov said the offshore drilling industry's cycle bottomed out in April and that recovery in the industry traditionally takes between 18 and 20 months. A standard indicator of the cycle is the percentage of rigs under contract, he said, with 85 percent near the top. Current rig use worldwide is at roughly 74 percent, up from around 60 percent in April.